Flexibility

Flexibility refers to the unused debt capacity available with the company. The calculation of unused
debt is shown below:
Calculation of Unused Debt Capacity
AAA
AA
A
EBIT/I
23.4
13.3
D/Capital
5
35.9
2001
EBIT
Interest
AAA
AA
A
BBB
BB
B

BBB

BB

6.3
42.6

3.9
47

2.2
57.7

1.0
75.1

2002
344.8

2003
351.6

2004
358.7

2005
366.6

2006
375.4

14.7
25.9
54.7
88.4
156.7
344.8

15.0
26.4
55.8
90.2
159.8
351.6

15.3
27.0
56.9
92.0
163.0
358.7

15.7
27.6
58.2
94.0
166.6
366.6

16.0
28.2
59.6
96.3
170.6
375.4

UNUSED DEBT CAPACITY IN FUTURE FOR min.

EVERY CREDIT RATING
acceptable
rating
AAA

AA

BBB

BB

5.47%

5.50%

5.70%

6.30%

9.00%

12.00%

Rating

Year

Debt
Amount

Unused
Debt

Debt
Amount

Unused
Debt

Debt
Amount

Unused
Debt

Debt
Amount

Unused
Debt

Debt
Amount

Unused
Debt

Debt
Amount

Unused
Debt

of

Existing
Debt

Cost
Debt

161.5

2002

269.4

107.9

471.4

309.9

960.2

798.7

1403.
3

1241.
8

1741.
4

1579.
9

2873.
3

2711.
8

161.5

2003

274.7

113.2

480.7

319.2

979.1

817.6

1431.
0

1269.
5

1775.
8

1614.
3

2930.
0

2768.
5

161.5

2004

280.2

118.7

490.4

328.9

998.9

837.4

1459.
9

1298.
4

1811.
6

1650.
1

2989.
2

2827.
7

161.5

2005

286.4

124.9

501.2

339.7

1020.
9

859.4

1492.
1

1330.
6

1851.
5

1690.
0

3055.
0

2893.
5

161.5

2006

293.3

131.8

513.2

351.7

1045.
4

883.9

1527.
9

1366.
4

1896.
0

1734.
5

3128.
3

2966.
8

D/C ratio (if unused debt included and assuming same no. of shares outstanding as 2001)
Total Equity
Maximum Debt
D/C ratio

AAA
AA
A
BBB
BB
B
2665.361 2665.361 2665.361 2665.361 2665.361 2665.361
269.4
471.4
960.2
1403.3
1741.4
2873.3
9.18%
15.03%
26.48%
34.49%
39.52%
51.88%

If BBB is to be target minimum debt rating, then the firm will need to adjust its debt from $161
million toward the $1 billion level.
COST OF FUNDS CALCULATIONS
AAA
Cost of Debt (pretax)
Tax rate
Cost of Debt (post tax)
Cost of equity
Wd (2002 data)
We (2002 data)
WACC

AA

BBB

BB

5.47%
38%

5.50%

5.70%

6.30%

9%

12%

3.39%
10.25%
9.18%
90.82%

3.41%
10.35%
15.03%
84.97%

3.53%
10.50%
26.48%
73.52%

3.91%
10.60%
34.49%
65.51%

5.58%
12%
39.52%
60.48%

7.44%
14.25%
51.88%
48.12%

9.62%

9.31%

8.66%

8.29%

9.46%

10.72%

WACC = Wd x (Cost of Debt (post tax)) + We x (Cost of Equity)

The BBB rating has got the lowest overall Cost of Funds.

Cost
16.00%

14.25%

14.00%
12%
12.00%
10.00%

10.25%
9.62%

10.35%
9.31%

10.50%
8.66%

10.72%

10.60%
9.46%
8.29%

7.44%

8.00%
5.58%

6.00%
4.00%

3.39%

3.41%

3.53%

3.91%

AAA

AA

BBB

2.00%
0.00%

Cost of Debt(Post Tax)

Cost of Equity

BB
WACC